Sylvia Ponders the Ups and Downs of the Stock Market

August 5, 1998

(A slightly revised version of this article appeared as "Dow drop causes headache, but it's time to sit tight," in Business Forum, Green Bay Press-Gazette, August 8, 1998.)

As the stock market fell during the week, Sylvia’s headache started to worsen. As if it wasn’t enough that her portfolio had gone through the wringer, she had to endure endless expert analyses of the market’s decline. Everywhere she looked, there was a pundit holding forth on what ailed the stock market. No medium was immune from the outpourings of these self-appointed gurus -- television, radio, the Internet, the newspaper, even -- gasp! - the Business Forum of the Press-Gazette.

Sylvia noted that the blame for the market decline rested largely on slowing economic growth, a sharp reduction in anticipated corporate earnings, and Asia’s continuing financial malaise.

After years of robust economic growth, the U.S. economy seemed to be running out of steam. While consumer spending remained strong, aggregate spending in the economy was being reined in by declining expenditures on capital goods by firms and decreased exports to the rest of the world. The fall in exports could be attributed in large part to the economic woes of East Asia - with their currencies plummeting and economies mired in a protracted recession, U.S. exports to the region had taken a severe beating.

The fall in aggregate spending on U.S. goods and services resulted in a sharp deceleration of economic growth in the second quarter. While GDP grew 5.5 percent in the first quarter of 1998, it rose by a meager 1.4 percent in the second.

The decline in the economy’s output, Sylvia noted, has sparked fears that corporate profits are about to follow suit. Years of sparkling corporate earnings performance were about to come to an end.

And so were, warned the analysts, the heady days of 20 percent annual returns in the stock market. Sylvia recalled with faint pleasure how her 401(k) portfolio had grown to almost monstrous proportions in the last few years.

The stock market’s remarkable ascent in the last three years had been fueled largely by the growth in corporate earnings; as long as profits rose handsomely, investors were willing to pay ever-higher prices for stocks. Now all that looked likely to change. With the future of earnings suddenly in doubt, investors had become more skittish about paying inordinately high prices for an Intel or an share.

Perhaps she shouldn’t have bought that Yahoo! stock, thought Sylvia pensively. But it was so easy to buy stocks these days, especially over the Internet. At a scant $8.95 a trade, who could resist...?

While the reasons for the stock market’s recent brush with misfortune seemed convincing, Sylvia also noted another explanation for the event. According to newspaper reports, one Mr. Ralph Acampora had something to do with the 300-point decline in t he Dow on August 4th. Sylvia learned that Mr. Acampora, an analyst at Prudential Securities, had earlier in the day pronounced that the Dow could fall to around 7,500 in the next few months. This revelation came as a bombshell on Wall Street, for it was n ot too long ago that the same gent had pronounced that the Dow would surpass 10,000 this year!

Sylvia realized that the year-to-date impressive gains of the stock market masked enormous variations in the performance of various asset classes. The rise of the major market indices, particularly the Dow and S&P500, had been propelled by the performance of the stocks of large corporations (Microsoft, Coca Cola etc.); less noticeable had been the declines - in some cases the complete rout - of smaller stocks. Already, many stocks had undergone bear markets of their own, losing more than 20 per cent of their value since the beginning of the year.

Sylvia winced at the thought of her holdings in Lycos. Far off from its previous high of $107, it now traded at less than half of that. Ouch.

A great deal of the analysis was overly pessimistic. A market decline, Sylvia noted witheringly, was enough to bring out the long faces. Even if the market fell to 8000, we would still be where we were at the beginning of 1998. No big deal, thought Sylvia stoically; investors weaned on the Roaring ‘90s would learn that stocks were risky after all. And in any case, all was not doom and gloom. There were those who pointed out the still-strong fundamentals of the economy -- low unemployment, negligibl e inflation, low interest rates, a budget surplus, buoyant consumer confidence. True, growth had slowed, but the current inflation-free environment made it easier for the Federal Reserve and Alan Greenspan to employ monetary policy to combat any significa nt downturn. Also, the emergence of budget surpluses in Washington meant that the government would be more amenable to using fiscal policy -- increasing government spending or cutting taxes -- for the purpose of stimulating economic activity.

Her headache had become much better, Sylvia realized. A full-fledged stock market crash appeared unlikely. The market might continue to decline, especially if forthcoming earnings announcements revealed a grimmer picture of the economy. But for now , she would sit tight, perhaps even buy a few stocks that she had her eyes on for some time. Perhaps something that Warren Buffett had bought recently? Hmm....

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